Stress in US financial markets has dropped to its lowest level on record, according to a widely-watched index, after the Federal Reserve sought to ease strains in short-term borrowing with a huge injection of cash.
The St Louis Fed financial stress index fell to minus 1.6 for the week ending January 17, it said this week — the lowest reading since the index was created at the end of 1993.
The measure has been negative for several years but has lurched lower in recent months, as the US central bank has tried to boost the amount of cash in the financial system following an unusual bout of volatility in the overnight repo market, where investors borrow cash in exchange for high-quality collateral like US Treasuries.
That prompted the Fed to commit to buying $60bn of Treasury bills every month, resuming the expansion of its balance sheet, which had steadily shrunk under its previous “quantitative tightening” programme.
“The Fed’s extremely aggressive response to the repo blowout in September, as well as their timidity in pulling back from that response . . . could be signalling to markets that this is a Fed with a very low tolerance for market fluctuations,” said Blake Gwinn, a strategist at NatWest Markets, who joined the bank last year from the markets group at the New York Fed.
The central bank has repeatedly said its latest round of debt purchases is not the same as its post-financial crisis interventions known as QE, or quantitative easing, when it bought bonds explicitly to lower long-dated interest rates and ease financial conditions.
This time around the central bank has said it is simply trying to protect the market’s plumbing, but analysts note that the effects are hard to distinguish from straight QE. Some have argued that as the Fed has bought T-bills, investors have been nudged into alternative investments such as stocks and corporate bonds, pushing prices higher.
This month Dallas Fed president Robert Kaplan became the first Fed governor to say that bill purchases are affecting other asset prices. He has since been joined by Larry Kudlow, President Donald Trump’s top economic adviser.
“The Fed goes out and buy bills, the seller of bills then buys coupons, the seller of coupons then buys credit and the seller of credit buys riskier credit,” said Andrew Brenner, head of international fixed income at NatAlliance Securities. “There is so much excess money.”
Funds focused on buying US bonds have taken in $115bn since the beginning of October, when the Fed announced it would begin buying Treasury bills, according to data from EPFR Global. The yield on risky, junk-rated debt fell to a five-year low of 5.14 per cent earlier this month.
The equity market has also rallied since the Fed began its purchases, up more than 11 per cent since the beginning in October.
The St Louis Fed’s stress index tracks 18 data sets, including measures of interest rates and bond yields. Almost all of the measures are drawn from US markets, with the exception of an emerging markets bond index. A negative number indicates below-average financial stress.
“The expansion of the balance sheet — whether [the Fed] calls it QE or not — is good for risk sentiment,” said Scott DiMaggio, co-head of fixed income at AllianceBernstein in New York.